Standing Committee A

[Mr. Joe Bentonin the Chair]
(Except clauses 13 to 15, 26, 61, 91 and 106, schedule 14, and new clauses relating to the effect of provisions of the Bill on section 18 of the Inheritance Tax Act 1984)

Clause 23

Charges and rates for 2006-07

Question proposed, That the clause stand part ofthe Bill.

John Healey: May I begin by welcoming you to the Chair, Mr. Benton? I have had the pleasure of serving previously under your chairmanship and that of your co-Chair, Mr. O’Hara. I look forward to doing so again.
It may not feel like it to members of the Committee, but we have now reached part 3, chapter 1 of the Bill. Clause 23 imposes income tax for the year 2006-07. The starting rate of 10p, that we first introduced in 1999, means that more than 3 million low earners continue to see their marginal rate of tax halved. We have kept our election promises not to raise the basic or the top rate of tax, which remain at 22p and 40p respectively, and the 22p basic rate is the lowest basic rate in the UK for more than 70 years. The income tax rates set out in the clause are part of the Government’s commitment to maintaining macro-economic stability and sound public finances. I commend the clause to the Committee.

Mark Hoban: I, too, welcome you to the Chair, Mr. Benton. The stand part debate presents an opportunity to mention the issue of the proposed shortening of filing deadlines for income tax self-assessment returns, as outlined in the Carter review that was published at the time of the Budget. The review’s recommendations were accepted by the Government. For those submitting their tax returns for the 2007-08 tax year online, the filing date will be 30 November 2008, whereas for those submitting their income tax returns on paper, as all Members of the House currently have to do, the deadline will be 30 September 2008, instead of the existing filing date of 31 January in the year following the end of the tax year.
The consternation that the proposal has caused among tax advisers can be imagined—they are concerned about the impact that it will have on them and on their clients. The news section of TaxationWeb has an item that says:
“FILING DATE PROPOSAL HAS TAX ADVISERS ‘UP IN ARMS—A campaign against a proposed 30 November deadline...has signed up 2,500 supporters in less than four weeks.
The specialist magazine Taxation launched its ‘No to November’ campaign on 13 April. Editor Mike Truman told TaxationWeb that completed forms were still arriving at the rate of about 100 a day. Only one correspondent so far has said he agrees with the proposal.
Frank Askew, of the ICAEW”—
I should declare that I am a non-practising member of the Institute of Chartered Accountants in England and Wales—
“said ‘It is very disappointing that this recommendation has been accepted by the Government with no debate and consultation.’
Ann Redston”—
the chair of personal taxes at the Chartered Institute of Taxation—
says ‘There has been no consultation with taxpayers or agents on this measure. HMRC should first find out if this idea is practicable before they announce such a radical change. Consultation should precede decisions, not follow them.’
She continued:
“This is putting the ‘Carter’ before the horse.”

Helen Goodman: Is the hon. Gentleman not aware of the National Audit Office report on tax collection, which was produced at the end of last year? The NAO, and indeed the Public Accounts Committee, found that the long deadlines are one of the reasons why people make mistakes and do not submit their tax returns at all. That is one of the main reasons for changing the administration.

Mark Hoban: The hon. Lady makes an interesting comment and I shall return later to the report of the Public Accounts Committee. However, shortening deadlines could also lead to more mistakes and problems with tax return submission.
Tax advisers have good reason to be concerned about the lack of public consultation. It is certainly not in line with the HMRC’s guidelines on consultation, and the lack of consultation has been remedied not by publishing and circulating a consultation document but by asking professional advisers to comment on the partial regulatory impact assessment. That is not a very satisfactory way to gain tax advisers’ and their clients’ consent and agreement to the change.
The other aspect that concerns me is the impact that the proposals will have on three key groups: taxpayers, their agents and the HMRC itself. Taxpayers must produce information to enable them to complete their returns on time. Hon. Members will know from completing their own tax returns that, depending on how simple or complex they are, a great deal of information can be needed. Some of that information is supplied in line with statutory deadlines. For example, Members should receive a P60 by 31 May and, where applicable, a P11D by July of each year.
For other providers, however, no such statutory requirements exist. Often, information is provided only on an annual basis—for instance, on the anniversary of a particular policy or investment—and there is no consensus on when that information should be received. Taxpayers will have to wait for information before they complete their tax returns, and will have a shorter period in which to complete them.
Taxpayers in seasonal occupations are also an issue. We mentioned that topic in debate last week. Many people who complete self-assessment forms are self-employed in small owner-managed businesses. They will face challenges when trying to achieve those deadlines. Businesses will have to use the time between the end of March and September to finalise their returns. By bringing forward the filing dates for assessment, the Government will compress the time that small businesses have to complete their returns for tax and other purposes, placing an additional burden on them.
We know that certain sectors have seasonal peaks in their work load. A large amount of the tourism and hospitality sector’s business is done during the time when the new filing deadlines will require businesses to complete and finalise their returns. The farming sector spends the time between July and September bringing in the harvest. Farmers will want to use those hours to harvest their crops, not to complete income tax self-assessment forms.
As we heard on Thursday, auctioneers and people who work in the art market find their own seasonal peak in the summer. They too will find it difficult to produce their returns. According to research undertaken by the Association of Chartered Certified Accountants, 54 per cent. of its members feel that the revised dates will have a negative impact on businesses engaged in seasonal trade. The pressure of assembling the information required for self-assessment during that period and completing the form will place additional burdens on individuals at their busiest time of the year.
A number of people will employ agents to complete their tax returns. Such agents will have issues managing their work load. In April, they will need to complete year-end returns for the HMRC; in May, they will deal with P60s on their clients’ behalf; in June, they will deal with P11Ds; and they then normally experience a lull in their work load until September when some paper returns are finalised and again in January when returns are finalised.
That is not to say that outside those peaks, agents are twiddling their thumbs. Often, they do audit and accountancy work on their clients’ behalf and offer high-quality business advice. Such agents will find their work load and their ability to manage it challenged. Some 91 per cent. of respondents to research on the impact believe that the Carter review will have a significant impact on tax agents’ working practices.
Agents want to ensure an even flow of work throughout the year. They have an interest, as does the HMRC, in doing so. It is easy to forget the scale of operations undertaken by some tax agents. A medium-sized practice with 13 individuals in its tax department might process as many as 3,500 returns. It normally starts to receive information from the majority of its clients in early August. By the end of November, a practice of that size has received back the information required for about 80 per cent. of its clients, submitted draft returns for approval to about 65 per cent. and filed about half of those returns with the HMRC already. That is by November, the latest date under these recommendations for filing online returns. If the deadlines were brought forward, that would bring forward the timetable for clients and their agents.
It is not just advisers and their clients who will have a problem; the HMRC needs to deal with the issue as well. It has two work load peaks, one near the self-assessment filing date in January and the other at the annual return deadline in May. The concern is that the arrangements will not smooth that workload but will bring forward the peaks. The industry would hope to see taxpayers and agents receiving greater encouragement to file their returns earlier, so as to spread the work load. Tax advisers welcome a great deal of Lord Carter’s report, and they support his proposal to align the inquiry window with the actual, rather than the statutory, filing date, as they believe that that would encourage the smoothing of the work load.
The hon. Member for Bishop Auckland (Helen Goodman) referred to mistakes and errors in relation to the later filing deadlines. If the deadline were earlier, advisers, agents and businesses might submit provisional or estimated figures in order to meet the September deadline for paper returns or the November one for online returns.

Andrew Selous: An accountant in my constituency has informed me that the Revenue website cannot cope with partnership returns, capital gains or foreign income. Is my hon. Friend aware that people who receive such income will not be able to benefit from the two-month extension?

Mark Hoban: Indeed, and those are not the only types of income or clients that the Revenue’s website has a problem with. Members of Parliament cannot submit returns online at the moment. There is a great deal of work to be done to ensure that agents and their clients can submit online a range of returns reflecting the complexity of our tax system.
There is a risk that, with the shortening of the deadline, people will submit estimates or provisional figures. In addition, there is no electronic system for amending a tax return, so the HMRC will receive manual amendments that correct, update and revise data submitted online in accordance with the suggested deadline. As my hon. Friend the Member for South-West Bedfordshire (Andrew Selous) said, the current system for submitting tax returns online has limitations. As well as being unable to deal with the forms of income that he mentioned, the HMRC cannot accept additional documentation online so that, too, has to be submitted in paper format. It is clear that the implementation of the recommendations of the Carter review will create problems not just for advisers and their clients but for the HMRC.
The Public Accounts Committee report on theissue contains interesting evidence from the HMRC. On page 18 of the evidence section of the report,David Varney, the chairman of the HMRC, says of moving the paper filing deadline to September:
“Whilst this would provide a single combined date that already has currency for SA taxpayers, it would create an un-manageable paper filing peak in September as well as clashing with the tax credits renewal peak.”
Even the chairman of the HMRC recognises the problems that will be created by the Carter recommendation to bring forward that filing deadline. The report contains a graphic illustration of the peaks. The graph on page 16 demonstrates that there are peaks in both September and January for returns that are filed by post. If we move the deadline for filing paper returns from January to September, we will create a huge spike in the HMRC’s work load, dwarfing the number of returns submitted online at the moment. Even the HMRC recognised that problem, as did the Public Accounts Committee’s report, which acknowledged the major peaks in work load at the time of the September and January filing deadlines and highlighted issues around smoothing those peaks and improving the accuracy and efficiency of the tax system.
In conclusion, issues need to be resolved that affect taxpayers, their agents and the HMRC to ensure that their work loads are dealt with sensibly. It would be no answer to the PAC’s recommendations for smoothing the work loads if those of the HMRC, businesses and their advisers are simply compressed into short spaces of time creating an increase in the number of errors, estimates and re-statements that would require a long tail of remedial action.
It is a pity that those changes have not been introduced in line with the HMRC’s code of practice on consultation. That has caused a great deal of unhappiness and disappointment among tax advisers. In recent weeks, we have heard about the importance of consultation and agreement before major changes from the Treasury, yet it seems keen on pre-emptive announcements and deadlines for changes. It would have been far better to have discussed the matter with interested parties, rather than to have sprung the decision on them without warning.

Joe Benton: Before I call the next speaker, may I take this opportunity to remind the Committee that the clause is about rates and that although it is not unreasonable to allow those on the Front Bench a little latitude, we cannot have repetitive debate? I insist on that.

Julia Goldsworthy: I shall attempt to return to the substance of the clause, which is actually very straightforward because it leaves income tax rates as they have been for some time.
There is an issue of fairness. In a fair taxation system, those with higher incomes should pay a higher proportion of tax than those in the lower income brackets. In our taxation system, however, the bottom 20 per cent. of households pay 39.5 per cent. of their gross income in tax, whereas the top 20 per cent. of earners pay only 34.2 per cent. That might not be because of the income tax levels themselves, but because of other increases in, for example, national insurance and council tax, which year on year have risen above the rate of inflation. That has led to inequality in the system. What plans does the Financial Secretary have to make taxation fairer given those inequalities that still exist despite the existing rates of income tax?

George Young: I welcome you, Mr. Benton, to the Chair. I wish to add a brief footnote to the excellent speech that my hon. Friend the Member for Fareham (Mr. Hoban) made from the Front Bench. Much of the Finance Bill has little impact on the average taxpayer, but the change that he mentioned will by its nature impact on everybody who submits a tax return. They, and indeed the Committee, are entitled to a better explanation than the one that we have had so far for bringing forward the dates.
First, if we make those changes, there will be a penalty on those who, for whatever reason, cannot submit their tax returns electronically. They will have an earlier filing date. It would be helpful if the Financial Secretary explained why, 10 years after self-assessment was introduced—I was the Financial Secretary who introduced it—it is still not possible for Members or civil servants to submit their tax returns electronically.
Secondly, it would be helpful also if we could have up-to-date figures for the numbers of tax returns—electronic and paper—submitted between September and January so that we can see the impact of the proposed reforms. My hon. Friend referred to such figures from a PAC report. Those reforms would compress dramatically from July to January—the current time frame—to July to September or November, the effective working time in which tax returns are produced. Inevitably, that will concentrate them more in the holidays. It would have been better if there could have been slightly more effective consultation with those involved before those reforms were introduced.
According to a survey produced by the Society of Professional Accountants, 84 per cent. stated that the earlier filing dates were not readily attainable. I am sure that the Government do not want to introduce a reform that those who will have to deliver it believe to be unattainable. If the Government want to move the dates forward, perhaps they could stage the process and bring them forward one month at a time rather than all at once. That would allow the accountancy profession and taxpayers more time to adjust to the demanding schedule that the Government wish to impose.

John Healey: Clause 23 sets income tax rates only for the current financial year, but I have some sympathy with the hon. Member for Fareham, who tabled amendments to the clause that were judged to be outside the scope of the Bill. I say to him that the measures following Carter’s review are not in the Bill. We intend them to be in next year’s Finance Bill.
I shall pick up the point about consultation made by the right hon. Member for North-West Hampshire(Sir George Young) and the hon. Member for Fareham. In July 2005, we asked Lord Carter to advise us on increasing the usage of the HMRC’s online services. I do not accept that there has been no consultation. Many representations were made to Carter’s review team, which contained several tax agents from different fields. We published Lord Carter’s report at the Budget, and we issued alongside it a partial regulatory impact assessment. We specifically invited views and evidence on Carter’s recommendations from those in the fields involved and from anyone else, and we have set a deadline of 30 June for those consultations. There has been plenty of time to contribute and to influenceLord Carter’s thinking in the preparation of his report and our thinking on how we may implement his recommendations in next year’s Finance Bill.

Mark Hoban: I recognise that certain changes need primary legislation and will be introduced in the 2007 Finance Bill. It is interesting to note that evidence to the PAC suggested that the changes would have to be introduced in this year’s Finance Bill to be effective, in line with the recommendations of the Carter report.
For a change of such magnitude, tax advisers would have expected a discussion paper to be published and debated in the industry, rather than the Carter review being published and the Government saying that they would accept its recommendations. They expected a more formal process of consultation, rather than simply having to comment on the effectiveness of recommendations that the Government have already committed to accept and implement.

John Healey: I had not yet finished dealing with the process that we are going through to get in place eventually the measures that we feel are appropriate following the review that we asked Lord Carter to make. It is out for consultation and we have invited, and welcome, views and evidence. I shall take the hon. Gentleman’s comments in Committee as part of that process.
My hon. Friend the Member for Bishop Auckland was right to refer us to the National Audit Office report published in February. I say to the hon. Member for Fareham that the PAC takes a tougher line thanLord Carter on the mandatory filing of electronic returns. The purpose of the Carter review and of implementing its recommendations is quite clear: it is to have the most efficient tax service and system possible for taxpayers and to continue to support the necessary and proper efforts of the HMRC to ensure compliance. I do not want to get into the detail of Carter’s recommendations; we will have a full opportunity to do so when next year’s Finance Bill is published. I simply say that nobody will be required to file a self-assessment return online. We are looking to simplify the self-assessment to take as many as possible of those whose tax affairs are relatively simple out of the self-assessment system altogether.
Having rightly pointed out that the clause is straightforward, the hon. Member for Falmouth and Camborne (Julia Goldsworthy) asked a much more general question about fairness in the tax system. I remind her that, as a result of the personal tax and benefit reforms that the Labour Government have put in place since 1997, in real terms this year, households will, on average, be £950 better off. Families with children will, on average, be £1,500 better off and families with children in the poorest fifth about whom she is worried will, on average, be £3,400 better off.
When we consider the income tax rates under the clause alongside the operation of the tax credit system, about four in 10 families now pay no net tax. A two-child family earning up to £21,000 as a result of the combination of the tax and tax credit system pay no net tax. I say to the hon. Lady that, in my book, that is a fair tax system and it is one that we are keen to protect and develop.
I welcome the contribution of the right hon. Member for North-West Hampshire who was a much more distinguished Financial Secretary. It is still not possible for Members of Parliament to file their tax affairs online. He will know that there remain long-standing concerns about the additional safeguards that are judged appropriate for the tax affairs and personal data of MPs. There have been lengthy debates on the subject that, in some cases, pre-date the current Government. That is why the HMRC still handles those tax returns separately from the system that is set up for other taxpayers.
I hope that with my explanation and my final reassertion of the fact that we expect to bring forward a packet of measures to implement specific proposals following Carter in next year’s Finance Bill, when there will be a full opportunity for the sort of the debate that the hon. Member for Fareham wants in Committee this morning, the Committee will allow the clause to stand part of the Bill.

Question accordingly agreed to.

Clause 23 ordered to stand part of the Bill.

Clause 24

Charge and main rate for financial year 2007

Question proposed, That the clause stand part ofthe Bill.

John Healey: I will attempt to be brief on this clause, too. The Labour Government are committed to maintaining a modern, fair and competitive corporation tax system. That is becoming more important in what is increasingly a more flexible and competitive global trading environment. Since 1997, we have therefore attempted in part to promote enterprise by reducing the headline rate of corporation tax from 33 per cent. to 30 per cent., the lowest United Kingdom corporation tax rate since its introduction. Alongside that, we have introduced several more targeted measures, including relief for research and development costs, which we shall debate under future clauses.
The clause will enable corporation tax to be charged for the financial year 2007-08. It sets the main rate for that year at 30 per cent., which is no change from the current rate. I commend the clause to the Committee.

Julia Goldsworthy: The Financial Secretary talked about competitiveness. Although corporation tax rates have fallen in recent years and have remained unchanged since 1999, they have been falling in other developed countries. I should therefore be interested to know what investigation his Department has carried out into whether the United Kingdom looks set to remain an attractive place for investment compared with other countries. I want also want to know his future projections for revenues from the tax since, in 2004-05, the UK revenues from corporation tax, excluding North sea oil, represented 2.6 per cent. of the total tax take. Including North sea oil revenues, the figure is 3.3 per cent., which is very high for countries in the Organisation for Economic Co-operation and Development. I shall be interested to know what future implications he thinks that that will have for competitiveness. Are the taxes are being relied on more heavily because of the commitment not to increase income taxes?

John Healey: The hon. Lady is right to say that maintaining a competitive economy and tax system is a continuing challenge. She asked me about corporation tax projections, which are set out as normal in the pre-Budget report and the Budget. It makes no sense to strip out the corporation tax returns and projections from a particular sector of the economy as she tried to do. I remind her that the World Economic Forum’s most recent global competitiveness report ranked the UK as the most competitive of all the major European countries.

Question put and agreed to.

Clause 24 ordered to stand part of the Bill.

Clause 25

Small companies’ rate and fraction for financial year 2006

Question proposed, That the clause stand part ofthe Bill.

John Healey: The clause sets the small companies’ rate of corporation tax for the financial year 2006-07 at 19 per cent. for companies with under £300,000 profit; it is unchanged from previous years. The clause also sets the fraction used for calculating marginal relief on the main rate at 11/400ths, which ensures that companies with profits between £300,000 and £1.5 million face a smoothly rising average tax rate. That is also unchanged from the previous year. I commend the clause to the Committee.

Question put and agreed to.

Clause 25 ordered to stand part of the Bill.

Clause 27

Group relief where surrendering company not resident in UK

Question proposed, That the clause stand part ofthe Bill.

Joe Benton: With this it will be convenient to discuss new clause 7—Interpretation of Chapter IV of ICTA—
‘In section 413 of ICTA, after subsection (10) add—
“(11) This Chapter shall apply notwithstanding the terms of the European Communities Act 1972.”.'.

John Healey: The clause introduces schedule 1 and together, they provide for a small extension to the group loss relief rules for companies, which will allow UK groups to claim corporation tax relief for foreign losses in some very limited circumstances. I put it on the record so that it is clear that existing group relief rules for UK losses, which business is understandably keen to retain, are unaffected by the proposal.
The Government are introducing this small extension to group relief following the decision last December by the European Court of Justice in the case of Marks & Spencer v. Halsey. In that case, the court ruled that the UK’s group loss relief rules are in principle compatible with European law, but they go too far in denying relief for foreign losses in some narrowly defined circumstances: where a UK parent company can show that a foreign subsidiary has exhausted all possibilities of relief in its state of residence.
With effect from 1 April this year, our domestic tax legislation will be changed by the clause to reflect the decision taken by the European Court of Justice, making it clear that relief will be available in some limited circumstances to a UK parent company and its UK subsidiaries for the tax loss of a foreign subsidiary. That foreign subsidiary must either be resident in the European economic area or have made the loss in a permanent establishment based in the European economic area.
Schedule 1 sets out new conditions and rules. To ensure that they are observed the UK claimant company will be responsible for showing that all the conditions for the new relief are met. That is necessary because losses surrendered under the new rules will be from foreign companies that are not generally subject to UK law. Although the relief will be available only in the narrow circumstances set out in the schedule, the Government became aware that some people were planning arrangements with the aim of obtaining relief in the UK where it would not otherwise have been available. My right hon. Friend the Paymaster General announced on 20 February that relief in the UK would be denied where such arrangements are made. The schedule contains provisions that will give effect to the announcement from that date.
Mr. Benton, you are encouraging us to debate new clause 7 at the same time as clause and schedule stand part, so perhaps I may take briefly the opportunity to deal with it. It is interesting that it was tabled by the hon. Member for South-West Hertfordshire (Mr. Gauke), rather than his party’s Front Bench spokesmen, and it will be interesting to see what they do if he presses it to a vote.
This is an extraordinary new clause; it could have been drafted by the European People’s party in the European Parliament—perhaps it was. Its intention is clearly to pretend that the European Union does not exist and, therefore, has no impact on the UK tax system. I explained earlier why, in our view, clause 27 and schedule 1 are necessary and reasonable. Just as importantly, we cannot renege on our treaty commitments in the way that the new clause encourages and suggests that we do; it is impossible for us to do that. Simply seeking to say that existing legislation applies notwithstanding the European Communities Act 1972, does not set aside those commitments, even though the hon. Gentleman may wish to do that.
On the important central point, it is right—it is the Government’s clear policy—that member states should have the power to determine the shape of their own tax systems. Other treaty provisions make it clear that that competence is preserved. We are not endangering that power to determine our own tax policy by introducing the clause and the schedule; we are simply aligning our law with the latest developments in European Union jurisprudence in an area specifically related to the internal market.
In conclusion, clause 27 and schedule 1 make provision for a small extension to the group relief legislation, to make it clear how relief from foreign losses will be available in certain narrow circumstances, and enable us to preserve existing group relief for UK losses. I commend the clause to the Committee.

David Gauke: I am grateful for the opportunity to speak on the clause and on new clause 7. As the Financial Secretary said, the purpose of clause 27 and schedule 1 is to ensure that our group relief laws comply with the European Court of Justice judgment in the Marks & Spencer case. This is not the first occasion—nor will it be the last—on which it is necessary for us to amend our taxation laws to comply with ECJ judgments. I raised the significance of the impact of the ECJ on our corporation tax law during Second Reading and I have no intention of running through the complete history of this matter again.
It is also worth noting that there is a widespread consensus in the UK in opposition to tax harmonisation, particularly relating to direct taxation. I welcome the Financial Secretary’s saying that it is right that we determine our own tax policy. The Chancellor of the Exchequer has stated that
“we must explicitly reject old flawed assumptions that a single market should lead inexorably to tax harmonisation”.
It is sometimes tempting to think that tax harmonisation is simply about rates, but it is not. It is broader than that; it is also about exemptions, reliefs and thresholds. Although the Financial Secretary states that it is right that we determine our own tax policy and this measure is only to align group relief with regard to the latest developments in EU jurisprudence, it cannot be considered in isolation. Since 1996, a series of judgments by the ECJ has determined that our tax laws have not been in compliance with European law in respect of provisions relating to freedom of establishment under the single market.
When this matter was debated on Second Reading, the Paymaster General was understandably quick to point out that this is Conservative legislation and that the various ECJ judgments are a consequence of that. However, it is also worth pointing out that at the time of the Single European Act there was no expectation that the various freedoms of establishment and other freedoms set out in that Act would apply to direct taxation. There was no explicit mention of direct taxation. All attempts at giving EU institutions jurisdiction over direct taxation had been rejected by member states. There was also an argument, widely accepted until relatively recently, about the need for fiscal cohesion, and therefore that single market provisions should not be used to strike down national laws.
The Marks & Spencer case determined that it was in breach of European law to allow profits and losses made by UK residents to be offset against each other but not to allow losses made by a subsidiary resident outside the UK, but in the EU, to be offset against the UK group company. As a consequence, the Finance Bill amends our law with the intention of complying with this judgment and subsequent judgments made in the UK courts. But as I said, this is not the first case and it will not be the last where we are required to do this.
Consortium relief, advance corporation tax and thin capitalisation rules have all had to be reformed as a consequence of ECJ judgments. In addition to the reforms of group relief being discussed today, we can expect the ECJ to determine against the UK in respect of franked investment income, and even since Second Reading, the Advocate-General has determined that our rules in respect of controlled foreign companies are illegal. The cost of these judgments to the UK Exchequer is considerable. Vast amounts of tax have to be repaid and the estimates that I have seen suggest that the cost to the Treasury of the Marks & Spencer case will be in the region of £3 billion to £4 billion. I would be interested to know what the Treasury estimates the ongoing annual cost of implementing the provisions contained in clause 27 and schedule 1 will be, as compared with being able to maintain the previous position, as my new clause 7 proposes.
There are those who argue that the change to the law in these circumstances, specifically in relation to group relief, is a good thing and that UK companies will ultimately benefit from the reform of group relief. That may well be the case. However, taken as a whole, I take the view that even with this Government—I am clearly not a supporter—the best interests of the country will be served if decisions about our tax system are taken by the democratically elected legislature of this country and not by a group of Luxembourg-based judges.
That brings me to the purposes behind my newclause 7. As the Financial Secretary has pointed out, new clause 7 amends section 413 of the Income and Corporation Taxes Act 1988 to state that the existing group relief rules shall continue in effect, notwithstanding the terms of the European Communities Act 1972. It reinstates the legal position as existed prior to the Marks & Spencer case. It sets out the law which this Parliament determined and says that that law shall continue to apply. It sets out the law which the Government wished to maintain throughout the Marks & Spencer case. It will also save the Treasury several billion pounds.
Will it be treated as valid by the UK courts? At this point, and at the risk of sounding like my hon. Friend the Member for Stone (Mr. Cash), I need to turn to the Factortame case—not that there is anything wrong in sounding like my hon. Friend. The Factortame case will be familiar at least to the lawyers among us.

Rob Marris: Three of them.

David Gauke: Not nearly enough, but we will make a start there. In brief and to simplify, the Factortame cases related to the Merchant Shipping Act 1988, which determined that in respect of shipping quotas, the UK quotas would be available only for UK persons. The ECJ determined that this was in breach of EU law. The House of Lords determined that the terms of the European Communities Act 1972 meant that the terms of EU treaties were to be incorporated into UK law and existing and future Acts of Parliament are subject to EU law.
Consequently, the Income and Corporation Taxes Act 1988, which contains the corporation group relief provisions, is subject to the provisions of EU law, as determined by the ECJ. The Act, in its present form, cannot stand because it is inconsistent with EU law, as the Financial Secretary rightly says. Consequently, the Government have considered it necessary to modify the law in order to comply with the views of the ECJ. However, the will of the current democratically elected legislature is not necessary for the case law of the ECJ to override the 1998 Act. Our role is to plug the gap in the least damaging way possible.
I want to explore the alternative approach that is set out in new clause 7. It is to state explicitly that UK law in its existing, enacted form continues to apply, notwithstanding any contrary principle of EC law. Returning to the Factortame cases, the essence of the judgment was the European Communities Act 1972. It entrenched EC law by giving it the capacity to override a later statute. The statute in question, the Merchant Shipping Act 1988, did not purport to repeal or exclude the effect of the European Communities Act. That gives rise to the essential question whether a later statute may, by express words, repeal or exclude the effect of the European Communities Act in giving effect to EC law.
The suggestion that the 1972 Act cannot be repealed or overridden is surprising, even if that is Parliament’s express intention. If that is not the case, the whole concept of parliamentary sovereignty is thrown out of the window. Some constitutional experts have suggested that that is the natural consequence of the Factortame decision and that the ECJ case law is for the supremacy of EC law. Reassuringly, the English Court of Appeal has refused to accept the argument. In Thorburn v. Sunderland City Council, the weights and measures or metric martyr case, Lord Justice Law stated:
“Whatever may be the position elsewhere, the law of England disallows any such assumption. Parliament cannot bind its successors by stipulating against repeal, wholly or partly, of the 1972 Act. It cannot stipulate as to the manner and form of any subsequent legislation. It cannot stipulate against implied repeal any more than it can stipulate against express repeal. Thus there is nothing in the 1972 Act which allows the Court of Justice, or any other institutions of the EU, to touch or qualify the conditions of Parliament’s legislative supremacy in the United Kingdom. Not because the legislature chose not to allow it; because by our law it could not allow it. That being so, the legislative and judicial institutions of the EU cannot intrude upon those conditions. The British Parliament has not the authority to authorise any such thing. Being sovereign, it cannot abandon its sovereignty. Accordingly there are no circumstances in which the jurisprudence of the Court of Justice can elevate Community Law to a status within the corpus of English domestic law to which it could not aspire by any route of English law itself.”

Joe Benton: Order. The hon. Gentleman’s remarks are becoming more generalised. Will he come back specifically to new clause 7?

David Gauke: I am grateful, Mr. Benton. I will not proceed with the quotation, but the direction in which it is going is clear. The purpose behind new clause 7 is to state that the law made by this legislature stands. An argument that may be used against it is that European Union law stands above it. There is nothing that we can do. It would be ineffective. There is an argument that new clause 7 would be entirely ineffective and that the British courts would not recognise it.
My view and that of numerous judicial authorities is that, where Parliament determines, as I propose it does in new clause 7, that an element of European Community law will not stand, Parliament’s will prevails. I should be grateful to know later in the debate whether the Financial Secretary agrees with that interpretation and whether we have that power. That still leaves the issue of our EU treaty obligations. I fully accept that were new clause 7 to be accepted and to become law, there are enormous issues with regard to our treaty obligations. I have no doubt that enforcement action would be taken by the European institutions against the UK. I should be grateful to know what assessment, if any, the Government have made of the likelihood of such action, and what the sanctions or fines are likely to be. I raise the matter because the fiscal costs of the various changes to EU law are considerable—I am talking about billions. We need, at least, to be able to evaluate all the options that are available to us.
My purpose in raising the issue, both on Second Reading and today by speaking to new clause 7, has been to highlight the increasing interference in our tax law by the EU. Secondly, I am trying to obtain a clear statement of Government policy on the matter, both in respect of the M & S case and more generally. Thirdly, I hope to clarify the constitutional position: has Parliament the right to insert an explicit override of EU law within legislation, and do the Government expect UK courts to recognise the validity of such an override?
The ECJ has played a prominent role in our deliberations during the last few sittings of this Committee. We have seen how it has damaged our competitiveness in the art market, and how the Government’s strategy to tackle missing trader intra-Community fraud has been scuppered by an ECJ judgment. Now we see that our corporation tax laws are being fundamentally amended because of the ECJ. We have to ask who should decide our tax laws—the democratically elected UK Parliament, accountable to the British people, or the judges of the ECJ? Is our purpose merely to implement our instructions from European institutions, and do we really think that that would be to the long-term benefit of our tax system and our economy? This might not be the time or place to determine such matters, but we have a responsibility to ask those questions.

Mark Hoban: I congratulate my hon. Friend on the way in which he made his case for new clause 7. He was right to highlight the way in which the ECJ is shaping the direct tax system in the UK. Of course, he refers particularly to the Marks & Spencer case, which underpins this clause and the schedule. When we discuss amendments to the schedule, I shall come to some of the issues arising from that case and the way in which the Government have responded to that judgment.
We should reflect on the fact that the case brought by Marks & Spencer used two articles—articles 43 and 48, relating to the freedom of establishment and the equality of treatment of member states—to argue the point that group relief should be available in the UK for losses incurred by overseas subsidiaries. Those articles have been used by businesses in other countries to amend or to force through changes to their own tax legislation. My hon. Friend mentioned the changes in capitalisation rules—I think that they were in the Finance Act 2005—that stemmed from a case that sought to unpick the rules on capitalisation in Germany that favour German businesses to the detriment of other businesses located there. In a way, that action helped the UK heads of corporate businesses to try to dismantle barriers in Germany.

David Gauke: It is also worth pointing out that, as a consequence of that case, we have had to amend laws that imposed a considerable bureaucratic burden on UK companies in order to show that transactions within a group took place on an arm’s length basis.

Mark Hoban: Indeed. As happens in such cases, if the determination of a matter of European law affects one member state, it might well have to be applied to other member states. A tax adviser has told me that the ECJ is interested not in tax avoidance in a particular member state but in tax avoidance that takes place across the European Union as a whole. There will inevitably be situations in which changes in one jurisdiction will lead to changes in other jurisdictions.
My hon. Friend made an eloquent case for effectively carving out direct taxes from the implications of the Single European Act, as that Act has been used to bring the case before us. However, we need to think carefully about the implications of doing so. He made a powerful argument in the context of tax, but I am sure that other legislatures could make equally powerful arguments about other matters covered by the Single European Act. Those seeking to withstand market liberalisation measures introduced by the Act might see a UK carve-out as an argument for a carve-out to protect their own services. Those Governments that seem inclined to protect their own businesses and withstand cross-border flows of transactions might see the carve-out as a reason to seek their own carve-outs from the Single European Act.
If we carve out direct taxes, what will other member states seek to carve out? We must be careful how we tackle the issue, because of what the consequences might be. Although we all subscribe to what the Chancellor said—
“we must explicitly reject old flawed assumptions that a single market should lead inexorably to tax harmonisation”—
the legislative bite required to put it into effect might have a knock-on effect on aspects of our relationships with other member states.
I come to another issue concerning the judgment and its application through the clause and schedule—the Government’s consideration of the ECJ judgment and its elaboration by Mr. Justice Park in the High Court. I shall deal in more detail later with the point that the Government’s interpretation of the ECJ’s judgment is far narrower than Mr. Justice Park’s. He said in his judgment that he did not feel he needed to return to the ECJ to clarify certain points left ambiguous as a consequence of its judgment; he felt that he could do that himself.
The Government’s interpretation and implementation of changes to group relief that are narrower thanMr. Justice Park’s judgment creates a risk that businesses will challenge schedule 1’s interpretation of the ECJ’s judgment, that they will push the Government on issues of timing, arrangements and other aspects and that the Government will incur great costs defending its narrow interpretation of the ECJ, to taxpayers’ detriment.
I shall make one specific point on the Government’s consideration of the application of ECJ judgments to tax policy. Some would argue that although the judgment in the Marks & Spencer case dealt specifically with group relief, which is available only when a parent owns 75 per cent. or more of the subsidiary, it should also apply to consortium relief and the rules for claiming group relief should be reflected in the rules for claiming consortium relief. It is argued in the light of the ECJ judgment that businesses will seek to take the Government to court in the ECJ, saying that if the Government are going to apply the ECJ’s judgment on group relief in a particular way, they should also make the same applications and changes to rules for consortium relief.

John Healey: The hon. Gentleman gives a reasoned exposition of his views, but he has not been clear about where he stands on new clause 7. Does he support it or not?

Mark Hoban: I think that I have given that explanation clearly already by highlighting some of the issues and the thought required before such a clause is put to a vote. I hope that, in the light of my remarks and given the thought that needs to go into how such a change might be implemented, my hon. Friend the Member for South-West Hertfordshire will seek the Committee’s leave to withdraw the new clause.

Joe Benton: Order. New clause 7 has not been moved, so there will be no necessity to withdraw it.

Mark Hoban: I am grateful. That will give my hon. Friend even more time to think about the matter before it is dealt with towards the end of our proceedings.
I conclude by saying that this stand part debate has raised important issues about the application of European law to tax. We cannot see it in isolation from the wider issues of reducing barriers to business across Europe, which we must examine carefully. We must remember that much of our economic success at home and abroad is due to the free movement of capital, both human and financial. We should be wary of making changes that, while satisfying us on one issue, damage us on a broader range of issues.

Rob Marris: I am grateful to the hon. Member for Fareham for rebuking the hon. Member for South-West Hertfordshire on new clause 7, perhaps better than I could have done. The new clause would be a first step towards taking us back to 1971, before the Heath Government rightly negotiated our accession to the European Union—the Common Market, as it was then called. It is a wrecking amendment and would wreck the UK’s position within the European Union. The hon. Member for South-West Hertfordshire was quite clear about that. He cited various cases, but as his colleague the hon. Member for Fareham pointed out, European Union law is a two-way process.
The hon. Member for South-West Hertfordshire mentioned the Factortame case; I assume that he meant Factortame No. 1 rather than No. 2 or No. 3. He did not talk about the debate within the EU, which is perhaps too wide for us to discuss today, on the horizontal applicability of directives in contra-distinction to their political applicability, or about cases such as Foster v. British Gas and the Francovich case in Italy on the applicability of EU directives. The EU is now a club of 25 members, all of which, including the United Kingdom, are at least in theory bound by the same laws. If new clause 7 were accepted, we would be seeking to opt out of that arrangement and see ourselves as distinct from the EU. The huge risk is that other member states would do the same, and we would end up with a fragmented EU. That would not be in the interests of the UK. In particular, it could adversely affect the position of the UK in financial markets, as the hon. Member for Fareham said.
London is the financial centre of the EU; most people would accept that, although perhaps the hon. Member for South-West Hertfordshire would not. One of the ways in which we have built on that position is by taking advantage of the financial rules of the European Union, which are binding on all 25 member states at least in theory and often in practice. If we were to start to resile from those rules, it would weaken the position of London and the UK within the EU, to our detriment. It might satisfy the hon. Gentleman’s view of where the UK should be going as a sovereign state, but it would be something of a little Englander approach and an own goal in financial matters. We have the leading centre within the European Union, a position that has been built upon in large part, though not solely, due to our membership of the EU. New clause 7 would seek to wreck that, and I urge my hon. Friends to vote against it if it is pressed to a Division.

John Healey: I appreciate the reasonable way in which the hon. Member for South-West Hertfordshire put forward his entirely unreasonable proposal. He has many colleagues who take an equally hostile view of the European Union but have generally framed their arguments in a less temperate tone.
The hon. Member for Fareham was interesting. He encouraged the hon. Member for South-West Hertfordshire to a point and then urged him to be cautious, particularly on the concept of carve-outs, for which he was arguing. My hon. Friend the Member for Wolverhampton, South-West was much clearer and more direct about the risks that such an approach might pose to our national economic interest.
On a number of points, the hon. Member for South-West Hertfordshire touches on the high principles of domestic and European Union jurisprudence. The simple legal fact at the heart of the matter is that the relevant Community laws are those concerning fundamental freedoms prescribed by European Community treaties and relating to cross-border movement between member states.
The hon. Gentleman also asked about costs. It is true that following judgment in the Marks & Spencer plc case, several reports suggested that the cost to the Exchequer would be high. However, they reported the outcome of the case in a way that was misleading;the judgment of the European Court of Justice was much narrower than was implied in those reports. The Government estimate that the cost to the Exchequer of the small extension of group relief proposed in this clause and schedule 1 as a result of the Marks and Spencer judgment, will be about £50 million a year. That estimate was set out and reflected in the Budget documentation. The Government are prepared to accept that cost in order to maintain the existing group relief that we believe is important and beneficial to UK business.
The hon. Member for Fareham made a number of points which, as he said, we will come on to in more detail later, but it is appropriate that I return to two of his points now. He took the Government to task by saying that the provisions in the clause and schedule are in fact narrower than Mr. Justice Park’s judgment. We have studied the ECJ’s judgment carefully and consider that the proposed extension to the group relief legislation is in line with the requirements in the EC treaty. The ECJ’s decision was very narrow—a view that has been reinforced by Advocate General Geelhoed. [Interruption.] I should spell that out for the Committee. The Advocate said that the judgment should be applied restrictively.
The hon. Member for South-West Hertfordshire asked about consortium relief. I am not sure if he is aware, but consortium relief is minute in comparison with group relief and typically accounts for less than a quarter of 1 per cent. of the volume and value of group relief. So we have concentrated our efforts on the effects of group relief because that has the greatest impact and effect on business. To be direct, the implications for consortium relief of the Marks & Spencer judgment are unclear, and we are still considering what—if any—consequences there might be. If we judge that it is appropriate to take action, we will do so, but only if we feel that it is necessary. I commend the clause to the Committee and if the hon. Gentleman wishes to press his new clause, I shall ask my hon. Friends to oppose it.

David Gauke: I am grateful to the Financial Secretary for his kind and generous words. I fear that I will have the worst of both worlds due to the manner in which I addressed the Committee earlier; I presented something that might be unpopular with some colleagues, but in such a way that I shall lose all credibility with some of my Eurosceptic colleagues.
When we evaluate our relationship with the European Union, it is important to take into account both the credit and debit sides. The purpose of new clause 7 is to highlight one of the disadvantages of our relationship with the European Union. Our tax system is being changed to our disadvantage, which is making it more difficult for the Government to raise revenue through corporation tax in the way that they would like. There is also a constitutional point about how there has been no consent from this House that direct taxation, in particular, should be a matter for the European Union. However, one has to accept that there is a wider picture. There are undoubted advantages to our membership of the European Union: anything that means that Peter Mandelson spends most of his time abroad has got to be a good thing.

Joe Benton: Order. We are not debating the merits or demerits of, or anything else about, the European Common Market. We are now discussing new clause 7, and I must ask the hon. Gentleman to return to that.

David Gauke: I merely say that new clause 7 highlights a particular aspect. My hon. Friend the Member for Fareham fairly makes the point that there is a larger debate, but it is not the purpose of this Committee to debate that now. I therefore have no intention of pressing new clause 7.

Question put and agreed to.

Clause 27 ordered to stand part of the Bill.

Schedule 1

Group relief where surrendering company not resident in the UK

Mark Hoban: I beg to move amendment No. 25, in page 150, line 7 [Vol 1], leave out from ‘arrangements' to end of line 9.

Joe Benton: With this it will be convenient to discuss amendment No. 28, in page 150, line 11 [Vol 1], leave out from ‘secure' to end of line 12 and insert
‘that the amount in question was not eligible for qualifying relief within the meaning of Schedule 18A paragraphs 6, 7, or 8.'.

Mark Hoban: The amendments concern the specific way in which the Government have chosen to implement the ECJ judgment, and I want to talk about something that the Financial Secretary highlighted in the clause stand part debate. He referred to a statement made by his right hon. Friend the Paymaster General in February, about the Government trying to close down any attempts made by UK companies to use the Marks & Spencer judgment to claim group relief and to enter into what was described as relevant arrangements to enable group relief to be claimed.
I should like to probe the arguments of the Financial Secretary about the clauses that concern those arrangements. It is fair to say that if someone were setting up a UK-based group of companies, they would seek to ensure that the shareholdings were such that they were able to claim group relief if losses were incurred in trading operations. They would check that they could offset the losses in one company against the profits in another for tax purposes. I would argue that that is a legitimate form of tax planning from the outset. Following the Marks & Spencer case, my belief would be that a UK parent company setting up subsidiaries overseas would, when starting up a new operation or new business, seek to structure the shareholdings so that they qualified for group relief. It may be that rather than encouraging an overseas investor to buy 30 per cent. of a subsidiary, they might ask that investor to buy just 24 per cent., so that they could qualify for group relief, and set up such arrangements from the outset. That is a perfectly reasonable form of tax planning.
However, there may be circumstances in which other arrangements are put in place, which would enable businesses to claim group relief on losses incurred by overseas subsidiaries. I should like to run through a few examples, to try to tease out from the Minister where he thinks the boundary lies between what he thinks is a sensible arrangement as part of the normal structure of a group and arrangements that might, in his view and that of the Treasury, be deemed to be tax avoidance. When companies are looking at structuring their businesses overseas, they need some certainties and some clarity.

Stephen Hesford: With respect to the hon. Gentleman, it seems that he wants to have his cake and eat it. If he accepts that the Marks & Spencer judgment has to be made clear in the Bill, how can he argue on one hand that we have to implement it—that is, in favour of Marks & Spencer and the wider regime for tax relief for groups of companies throughout the European Union, which I understand is the essence of the judgment—and also argue that it is wrong of the UK Government to narrow the proposal as far as possible so that Marks & Spencer does not take over-advantage of that situation? Is the hon. Gentleman in favour of Marks & Spencer getting away with it or is he in favour of narrowing down to the bare minimum? Which is it?

Mark Hoban: I am in favour of proper implementation of the ECJ judgment in the Marks & Spencer case. I will come to two issues that are connected with that matter in the next group of amendments. The schedule refers to relevant arrangements to enable companies to claim group relief. Anyone setting up a group structure from scratch and determining its structure would think about how to ensure that if losses do arise—no company sets out to make losses—they can flow through to UK tax computation and be offset against UK tax and profits. That is legitimate planning.
However, I am concerned about where the line is drawn between legitimate planning and the actions that people might take in order to make losses eligible for UK tax relief at a later date. There might be some tax structuring at the start of a new business opportunity, but people may find that the arrangements they make further on in the process, especially their choices about changes to group structures, for example, could make some losses eligible for relief in the UK, depending on their actions.
To help the hon. Gentleman, I give the example of a minority shareholder in an overseas company in which the UK parent owns 60 per cent. and a minority shareholder owns 40 per cent. If the minority shareholder exercises a put option, and requires the UK parent to buy those shares, which puts it over the 75 per cent. threshold for claiming group relief, the arrangements have not actually been made at the behest of the UK parent. If that happened as a consequence of actions by the minority shareholder, those actions will act as a trigger and enable the UK parent to claim group relief on the losses, assuming that there is no other way of obtaining relief in the country where the overseas subsidiary is located. However, because it is not their action or at the parent’s direction, they have not entered into the relevant arrangements for the purposes of securing group relief.
We have heard of cases in which the parent company may deliberately buy out the minority shareholding and decide to close down the operation, and in doing so goes over the 75 per cent. threshold, which in principle would render those overseas losses eligible for group relief in the UK. If that is the case and the parent actively seeks to acquire that minority interest, does that fall within the remit of the anti-avoidance provisions in the schedule?
We are trying to understand what actions a company can legitimately take that will trigger group relief which will not be picked up by the anti-avoidance claims. Is structuring from the outset okay? Will transactions later on fall inside or outside the anti-avoidance regulations? That is not clear, as the wording in the schedule is quite broad. People have a legitimate interest in understanding where the Government and HMRC will draw the line when considering what is permissible and what is not in relation to the structures of group companies.

John Healey: It is intended that the amendments should, as the hon. Member for Fareham said, alter certain detailed rules which would otherwise—as the clause and schedule are drafted—prohibit relief under the schedule in some circumstances. They would remove some of the protections in the legislation that prevent groups of companies from entering arrangements with a view to obtaining tax relief in the UK for foreign losses.
I should like to deal with some of the hon. Gentleman’s questions about the scope of our proposals. The European Court of Justice only expects cross-border loss relief in narrow circumstances, therefore it is important that we ensure in legislation that that is given effect and cannot be manipulated. The judgment in the Marks & Spencer case also makes it clear that Governments can adopt measures to prevent companies from seeking to achieve a tax benefit in one jurisdiction rather than another—in other words, choosing in which jurisdiction they will obtain relief for the losses. Just to be clear, the legislation does not prevent the movement of business activities. Section 403G only prevents loss relief from being obtained in the UK where a main purpose of the arrangements is to obtain group relief in the UK. That is the central provision, which, in some senses, answers the hon. Gentleman’s specific questions. I cannot give him a judgment on hypothetical or individual taxpayers’ cases. The purpose is to consider the motive in each particular case and instances would have to be examined on a case-by-case basis. HMRC has established procedures, with advisers and business, for doing just that.
In summary, I am concerned because the amendments would remove some of the important protections in the legislation. I am surprised that the Opposition have tabled such amendments. I should be interested to hear the hon. Gentleman say whether these are probing amendments, because he is trying to be much more generous with UK tax. It is not possible to be precise about the costs of the amendments, but without the protection that they seek to remove, the potential for abuse, which is our main concern, runs into hundreds of millions of pounds a year.
I hope that the hon. Gentleman will not press the amendment to a Division, but if he does, I shall ask my hon. Friends to oppose it.

Mark Hoban: I am slightly disappointed with the Financial Secretary’s response to the amendments, because people are looking for a greater degree of clarity about what the fairly broad paragraphs in the schedule are seeking to achieve. He referred to assessing the motive in each case and the procedures that the Revenue and Customs have to assess the purpose of transactions. I can see a range of corporate transactions that people could enter into.

Stephen Hesford: Will the hon. Gentleman give way?

Mark Hoban: I shall just finish this point.
Some of those transactions are currently regarded as legitimate and acceptable and others would unlock the losses for relief in the UK after a loss had arisen and some group structuring had taken place. The Financial Secretary is trying to capture such transactions in this anti-avoidance provision in respect of groups that undertake restructuring to unlock those losses for use in the UK, perhaps where there is an overseas subsidiary with an external shareholder with more than 25 per cent. of the shares in the company and some transactions have been entered into that change the direction or benefit of the taxpayers. We ought really to have some greater clarity on that.

Stephen Hesford: Is it not simply this? We have a judgment which we did not want and we are seeking to narrow that judgment down to protect the Rvenue in this country. Does he not agree?

Mark Hoban: I referred to that point in my earlier remarks. We want to see the judgment properly implemented. In doing so, we also need to give some clarity to taxpayers on the implication of that, particularly where actions are taken to minimise the scope for abuse and where we are looking for greater direction and clarity from the Government. I regret to say that I do not think that the Financial Secretary offered that clarity in this matter.
As I said at the outset, these are probing amendments. I will not push them to a vote but I hope that the Financial Secretary will reflect on ways in which further guidance can be given to taxpayers on the breadth of these anti-avoidance techniques. Would they inhibit or catch groups that were set up as perfectly legal and sensible business arrangements, but to which the Revenue might impute the motive of being set up to enable group losses to be relieved at some time in the future if a business is loss-making? Unless the Financial Secretary has further clarification to offer, I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Mark Hoban: I beg to move amendment No. 5, inpage 153, line 35 [Vol 1], leave out from ‘liability' to end of line 36.

Joe Benton: With this it will be convenient to discuss the following amendments: No. 6, in page 153, line 38 [Vol 1], after ‘every' insert ‘reasonable'.
No. 7, in page 154, line 19 [Vol 1], leave out from ‘liability' to end of line 20.
No. 8, in page 154, line 23 [Vol 1], leave out
‘immediately after the end of the current period'
and insert
‘when the claim for group relief was made'.
No. 9, in page 155, line 5 [Vol 1], leave out from ‘liability' to end of line 6.

Mark Hoban: These amendments deal with two different areas within the judgment of the European Court and particularly refer back to the judgment of Mr. Justice Park on 10 April 2006, where he tackled a couple of the issues that were perhaps ambiguous in the ECJ’s original judgment. I should like to deal first with amendments Nos. 5, 6, 7 and 9. One of the issues that was left outstanding in the minds of Marks & Spencer and their advisers, and on which they sought clarification from Mr. Justice Park, was the use in the ECJ judgment of the word “possibility”.
Mr. Justice Park’s judgment states at paragraph 33 that in his view when the ECJ refers to possibilities available, it means recognised possibilities, legally available, given the objective facts of the company’s situation at the relevant time. Some of the sub-paragraphs of the schedule refer to every possibility, rather than trying to be more specific about the nature of those possibilities.
Two issues emerge from Mr. Justice Park’s ruling. First, there are the legally recognised possibilities and whether those are available, given the objective facts at relevant times. Mr. Justice Park states that while there may be legal possibilities for group relief, the fact that they are available does not necessarily preclude losses in other EEA countries offsetting UK tax or profits. He goes on to discuss what is meant by objective facts at the relevant time and uses two examples to illustrate that. The first is where the overseas business is loss-making and still trading. He said that although the parent company might argue that the overseas subsidiary will not return to profit, the fact that it could—thereby offsetting its losses against future profits—would mean that those losses could not be used to offset UK taxes.
His other example was of a loss-making overseas company that had been closed. The losses had been fully utilised in that country, and a balance of unrelieved losses remained that could be offset against UK taxable profits. He said that the objective facts in that case proved that the losses could be relieved in no other way than against UK taxable profits.
Paragraph 6(4) of schedule 1 refers to “every step”, but what does that mean? Will HMRC examine what a UK parent company has done to turn around a subsidiary prior to closing it, in order to ensure that every step has been taken? What is the objective measure of any step? In the case of Marks & Spencer, the French subsidiary was sold to Galeries Lafayette, which then used the losses. If M&S had not tried to sell the business to Galeries Lafayette, would it still have satisfied the “every step” criterion? If it had not been able or had not tried to sell the business, would Revenue and Customs have said that the UK parent had not tried every step?
With the idea of every step, the Government are asking UK parent companies to know what purchasers have done with their losses. In the M&S case, it was known that Galeries Lafayette had used those losses to reduce its taxable profits, but most groups retain a degree of confidentiality about their tax affairs. There is no legal basis on which a parent that disposes of companies can find out what the acquirer has done with the losses.
My concern is that phrases such as “every step” and “by any other means” are poorly defined. In the effort to give better guidance to taxpayers, perhaps they should be either changed or qualified. That is why amendment No. 6 would insert the word “reasonable”. Amendments Nos. 5, 6, 7 and 9 seek to clarify what actions a claimant might take to meet the conditions for losses to qualify for offset against UK tax by defining more tightly the issue of possibility left hanging by the ECJ judgment.
The second issue that I shall tackle is that of timing, which is dealt with by amendment No. 8. The Government say in paragraph 7 of schedule 1 that a group relief claim should be made at the end of the current period. It is important for the Committee to know that UK companies claiming UK tax losses are allowed two years after the end of the current period to make a group relief claim. In defining so clearly the timing of the group relief payment for overseas losses, the Government are opening up a mismatch between the treatment of UK losses and the treatment of losses arising elsewhere in the European economic area.
In his judgment, Mr. Justice Park sought to elaborate on the ECJ judgment, which I understand was silent on the issue of when the group reliefclaim should be made. He identified three points at which the claim could be made. The first, in line with the Government’s new clause, is at the end of the accounting period when the loss was made. The second is at the time or times when the group relief claim is made by the parent—effectively a later date. The third is when the matter is dealt with by the special commissioners. I shall deal with the first two options.
Schedule 1 as it is drafted reflects the first option, yet it and the third option were ruled out by the High Court. In paragraph 44 of his judgment, Mr. Justice Park said that
“option 1 is too soon, and would be likely to rule out virtually every case.”
He went on to say:
“At the end of an accounting period in which M&SG and M&SB made a loss, and therefore was still likely to be carrying on its trade it is hard to imagine any case in which German or Belgian law would not provide for any possibility of relief for losses.”
So there could be a situation in which a business continues to trade at the end of a period. Say the financial year ends at 31 December and the business is still trading in Germany or Belgium, under schedule 1 any claim for group relief on those losses should be made. Given that the business is still trading at that point, and is likely to trade on into the next year, there is still the possibility in German or Belgian law—assuming that they allow for such possibilities—for those losses to be relieved against future profits. The only way in which a claim for group relief could be made in those circumstances would be if the business had closed during the current accounting period, so that it was known that there would be no future trade against which the losses could be offset, if they were unable to be offset in that year or in previous accounting periods.
The ECJ judgment is that, where possible, losses should be relieved in that country first, before being made available to offset in the UK company. If the decision had to be made at the end of the financial year, the company would know that there had been losses, but not whether there would be profit in future years against which that year’s losses could be offset. Because the possibility still existed to offset those losses against future trading profits, they could not be offset against UK taxable profits. In a way, the timing in schedule 1 makes it virtually impossible for a business to make a valid claim, because unless it is closed down in the course of the year, it will still be trading, so there will still be the possibility at the end of that financial year to make a claim.
Mr. Justice Park decided that the decision to make a claim for the use of losses should be made at the time at which the group submitted its claim for group relief. Such claims can be made up to two years after the end of the accounting period in which the losses were made. In those circumstances, a UK parent company could have much greater certainty about the possibility that the losses could not be relieved in the country in which the subsidiary was resident. For example, it could have closed a loss-making subsidiary, so it would know that there would be no tax on profits against which the tax losses could be offset.
If the Committee were to accept amendment No. 7, schedule 1 would reflect Mr. Justice Park’s judgment on the matter. My concern is not merely to achieve certainty for businesses and clarity on the timing, but—having seen Mr. Justice Park’s ruling, and the fact that he chose option 2—
“the time or times when the group relief claim was made by the parent”,
that some UK companies might seek to take the Government to court again to get them to comply with Mr. Justice Park’s original judgment.
The Government might say, “That is fine. We must go through that process and take it through the House of Lords and to the European Court.” However, asMr. Justice Park said in paragraph 41 of his judgment,
“A principle that runs through the whole of community law and has been enunciated by the ECJ in numerous cases is the principle of effectiveness: procedures in Member States must not render practically impossible or excessively difficult the exercise of rights conferred by Community Law”.
It appears to me that the drafting of schedule 1 ignores Mr. Justice Park’s judgment and the principle of effectiveness. It will leave the Government and taxpayers open to further challenge in the courts.

Stephen Hesford: Is it the hon. Gentleman’s view that all that Mr. Justice Park said was necessary in that case, or was much of it not necessarily directly relevant to what we are now considering? It is an opinion, but it is not necessarily one that the Government need to take as black-letter law at this time.

Mark Hoban: The hon. Gentleman opens up a can of worms in questioning the legal status of Mr. Justice Park’s judgment. To an extent, that goes back to the stand part debate, and the remarks of my hon. Friend the Member for South-West Hertfordshire about the primacy of Community law. If Mr. Justice Park’s judgment were seen as fleshing out the ECJ’s original judgment, should it be part of Community law? If it is part of Community law, will it have primacy over this legislation? I suspect that some people will go back to the ECJ about that. There is an important legal issue here about the status of Mr. Justice Park’s judgment in elaborating on the ECJ judgment. If we go down his route, we are saying that the Finance Bill overrides that judgment. However, as my hon. Friend has said, we know that parliamentary sovereignty is subservient to Community law. If Mr. Justice Park’s judgment is seen as elaborating on Community law, that may well prove ultimately to have primacy over the Bill.

Stephen Hesford: It was potentially an interesting, wider question that the hon. Member for South-West Hertfordshire asked. However, I am asking a very narrow question. Did Mr. Justice Park need to say, when he made the judgment in that case, what he said, or did he just go on, because he felt like going on to elaborate on areas that he did not need to elaborate on for the purposes of the case? If the latter, his comments were obiter, and therefore unnecessary as part of the letter of the law.

Mark Hoban: The hon. Gentleman, who was a barrister, would find it valuable to look at the judgment.

Stephen Hesford: You have got it.

Joe Benton: Order. Remarks must be made through the Chair.

Mark Hoban: My understanding is that Marks & Spencer went back to Mr. Justice Park for a ruling on the issues, and that he was specifically asked to clarify those points. In the detail of the judgment, he refers to representations made on the issues by counsel for both Marks & Spencer and HMRC. What he was saying on the matter was therefore relevant, and not simply some asides that we should not take into account in dealing with this schedule.

John Healey: Like you, Mr. Benton, I wanted to ensure that all members of the Committee had a chance to contribute if they so wished. These amendments would remove some protections in the legislation that ensure that relief is consistent with Government policy and the relevant European law, as expressed in the Marks & Spencer judgment. It is clear that the ECJ, in the Marks & Spencer case, intended relief to be given for foreign losses only in very limited circumstances, where all possibilities of relief had been exhausted elsewhere. The Court went out of its way to note that Governments are free to adopt measures to prevent artificial arrangements seeking to obtain a tax benefit.
I shall deal, as the hon. Member for Fareham did, with amendments Nos. 5, 7 and 9 together. They would undermine the purpose of the new schedule, which is to ensure that if losses have to be, or could be, relieved in future in another state, the UK is not obliged to give relief for them.
We still want to ensure that if a foreign company gets relief elsewhere, it cannot do so here. That is why a general description of other possibilities of obtaining relief is necessary in the legislation. The alternative would be an attempt to describe all the possible ways in which other countries provide relief for losses. Such a description would have to be updated each year. It would be burdensome for us to do and burdensome for business to follow, and it would carry the obvious risk that not all the possibilities of obtaining relief in the other EU member states had been identified.
As for the second issue raised by the hon. Gentleman, amendment No. 8 would change the date at which a determination must be made on whether a loss is potentially relievable for a future period in another state. He proposed an alternative approach and, in so doing, made reference to Justice Park’s recent High Court decision on Marks & Spencer. There is indeed a difference between the approach in Justice Park’s decision—members of the Committee might wish to know that that might not be the final word on the subject—and that in the Finance Bill as to the relevant time at which tests of unrelievability of foreign losses are to be applied.
The difference in position comes about because there are two different and distinguishable scenarios. The judgment of Justice Park applies only to the circumstances of Marks & Spencer. It applies in the context when the United Kingdom legislation does not contain provisions to allow relief on the losses of foreign subsidiaries. We are dealing under the schedule with legislation that, first, reflects the European Court’s decision in December last year and, secondly, translates that decision into UK legislation. In doing so, the Government have decided that the relevant time should be immediately after the end of the period in which the losses were incurred by the foreign subsidiary.
In setting out the legislation in such a way, we are relying on paragraph 55 of the European Court’s decision in the Marks & Spencer case. That paragraph sets out the conditions where, exceptionally, group relief should be extended to foreign losses. Our view is that those conditions are restrictive; that view was supported by the Advocate-General in another European case. When giving his opinion on class IV of the ACT group litigation case, he said:
“The court held that, in exceptional circumstances...a home State must extend domestic group relief”,
but that that extension
“should be applied extremely restrictively”.
The amendment would make the relief not restrictive, but more generous. However, it would not make it more equitable. In short, these amendments would remove important protections under the Bill, so I hope that, having said that they are probing, the hon. Gentleman will not press them.

Mark Hoban: I am grateful to the Financial Secretary for his response. I shall begin by dealing with the first aspect of the amendments. I understand his point about the requirement to specify in great detail the particular circumstances that would preclude losses being utilised, and indeed being offset. He made a valid and important point about that, which I accept.
On amendment No. 8, the Financial Secretary distinguished between the specific circumstances in the Marks & Spencer case and the decision of Mr. Justice Park, and the general position that is reflected in the schedule. I understand the Financial Secretary’s argument about restricting the availability of the losses and setting out a theme that runs through the proposals to which we have just referred.
I wonder whether, in practice, the Financial Secretary has taken restriction to a point at which it renders the possibility of claiming group relief almost impossible. He is asking businesses, at the end of the financial year, to make a decision about submitting a group relief claim for overseas losses. Before a business has had chance to work through the accounts, think about what the scale of the losses might be, implement some judgments made in drawing up a set of accounts and determine the loss, he is expecting it to decide whether it should submit a claim for group relief for overseas losses. He is asking businesses to do something impractical.
A business might be continuing to trade, but it could be thinking about closing down. The Financial Secretary is asking such a business to make decisions at the end of the financial year—without proper reflection, without the opportunity to draw up proper financial statements and without knowing the quantum of losses—and before it is able to determine whether the losses it has incurred in that year can be relieved against past profits or profits that have emerged during that year. For example, if a series of overseas subsidiaries are operating the same territory, how will the UK parent business know that their profits are greater than the loss incurred by that business that year? The losses can be offset against the profits of overseas subsidiaries in the same accounting period.
The Financial Secretary is asking businesses to know far more than they are capable of knowing and is applying the provision in such a restrictive fashion that it is impossible for those businesses to make a claim for group losses. This is an area on which the Government should reflect further. He is being restrictive in asking businesses to make decisions that they are not in a position to make at the end of a financial year. While I do not wish to press the amendment nor amendments Nos. 5, 6, 7 and 9 to a Division, I shall reflect on the issue. I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Amendment proposed: No. 22, in page 156, line 22 [Vol I], after ‘the' insert
‘relevant proportion (see sub-paragraph (5)) of the'.—[John Healey.]

Joe Benton: With this it will be convenient to discuss Government amendment No. 23.

Mark Hoban: I would be grateful if the Minister discussed the amendments. I have his letter to the shadow Chief Secretary about them, and while I appreciate the need for the Committee to move on at pace, it would be appropriate to explain their purpose. What does the Financial Secretary want to achieve by changing the definition of losses to be relieved and the comparison between UK measures of the EEA losses and other measures?

John Healey: The amendments will make minor technical changes to ensure that the amount of EEA losses that can be surrendered as group relief to UK companies is in line with the policy objective of preventing double relief for those losses. The previous version could have been read in two ways. That was not drawn to our attention by external sources, but it was something we spotted and decided to clarify with the amendments. I could go into detail, but I hope that the hon. Gentleman accepts that that is the reason for tabling amendments and how they have arisen. They will simply clarify technical changes. I hope that they are acceptable to the Committee.

Mark Hoban: I do not want to appear to be an anorak or pedantic about the changes, but the Government have sought to amend the Bill here. Is the Financial Secretary confident that, when EEA losses are restated using UK accounting rules and if those losses exceed original EEA losses, the higher value will not be offset against UK taxable profits?

John Healey: Yes.

Amendment agreed to.

Amendment made: No. 23, in page 156, line 32 Vol I], at end insert
‘and “the relevant proportion” means the proportion that the appropriate part of the EEA amount bears to the EEA amount'.—[John Healey.]

Schedule 1, as amended, agreed to.

Clause 28

Relief for research and development: subjects of clinical trials

Question proposed, That the clause stand part ofthe Bill.

John Healey: I rise to speak to the first of the two clauses dealing with research and development tax credits simply to emphasise the point, of which Labour Members are well aware, that the tax credits are a key part of the Government’s strategy to increase business research and development. In so doing, we will boost the levels of science and innovation in the economy to help to secure long-term prosperity.
Since the scheme was introduced in 2000 for small and medium-sized enterprises, the support claimed amounts to just under £1 billion for such enterprises and almost £1.8 billion overall. Early evaluation of the scheme suggests that companies claiming R and D tax credits generally find the process quite easy and find that it is having a positive impact on their R and D spending. However, we have constantly looked at ways to improve the package and to make it easier to apply for and more effective in its application. The amendments and changes announced in the pre-Budget report should improve the experience of companies claiming the credits. The announcement was widely welcomed, as was the fact that HMRC will set up dedicated units to specialise inR and D tax credit claims.
We also announced that the range of qualifying costs for the scheme will be expanded to include payments made to clinical trial volunteers. The clause will enact that announcement. It follows the suggestion put to us by the Association of the British Pharmaceutical Industry, which argued that the cost of paying volunteers for clinical trials is a legitimate R and D cost incurred by pharmaceutical and biotech companies and others undertaking medical research.
The clause also makes equivalent changes to vaccine research relief, which was introduced in 2002 to provide extra incentive for R and D on drugs and vaccines to treat or prevent diseases.

Brooks Newmark: At the end of last year, the then Minister for Competitiveness, the hon. Member for Brent, North (Barry Gardiner), said of the R and D tax credit:
“The truth is that it hasn't been a success. A lot of it has to do with a misunderstanding of what the R&D baselines were. We are trying to iron that out.”
While I appreciate that clause 28 will take out a wrinkle by including payments to clinical trial volunteers, does the Financial Secretary agree that the Government have some more ironing to do? I ask that question in the context of a comment by John Cridland, deputy director general of the CBI, who said:
“Companies are experiencing too much uncertainty and inconsistency in its application. That has to change if the Government is to achieve its target of R&D spending at 2.5 per cent of GDP by 2014.”
I would be interested to hear the Financial Secretary’s comments on that.

Jeremy Wright: I welcome you to the Chair, Mr. Benton.
Will the Financial Secretary engage in some joined-up government? I welcome what he said about the extension of relief for clinical trials, which is clearly a necessary and important move, but he will know that there are other reasons why it is difficult for companies, particularly smaller ones, to conduct such trials. Many of those are related to the European clinical trials directive. To see that the measure is enacted as effectively as he and I want it to be, it is necessary for him to speak to his colleagues in the Department of Health and to remove any administrative obstacles to the conduct of clinical trials so that advantage can be taken of the tax relief.

John Healey: Obviously, it is the Treasury’s role to set fiscal policy; the role of HMRC is to manage and administer that tax policy. We do so within the broader regulatory framework, for which other parts of the Government are responsible, but I shall draw the comments of the hon. Member for Rugby and Kenilworth (Jeremy Wright) to the attention of my hon. Friends in the Department of Health.
I say to the hon. Member for Braintree (Mr. Newmark) that, as I think I indicated in my short opening remarks, at each stage of the introduction of the R and D tax credit system—first for small firms, then larger companies—we have made it clear that we want to build on the emerging success. At each stage we have said that we shall look at possible improvements, including in the administration, and have welcomed the views of businesses, including that of the CBI, and their suggestions for improving the administration of the credit and payable allowance.
That was the intention behind the package of announcements in the pre-Budget report and the setting up of specialist units in HMRC, and that is why both were welcomed. The hon. Gentleman referred to the ironing out of some of the wrinkles in the system—I am keen on ironing; clause 29 does a bit of ironing too. I hope thereforethat he will support clause 28, and clause 29 when we get to it.

Question put and agreed to.

Clause 28 ordered to stand part of the Bill.

Schedule 2 agreed to.

Clause 29 ordered to stand part of the Bill.

Schedule 3

Claims for relief for research and development

Question proposed, That this schedule be the Third schedule to the Bill.

Joe Benton: With this it will be convenient to discuss new clause 5—Cost of claims for R & D—
‘The Chancellor of the Exchequer will publish a review in relation to the cost of making claims for relief for research and development before 1st March 2007 and will consult with organisations which have a special interest in claims for relief for research and development.'.

Mark Hoban: I should like to pick up on some of the Financial Secretary’s comments and those of some of my hon. Friends. Schedule 3 refers to the harmonisation of the timing of claims rules for R and D tax credits. In other contexts, harmonisation might not be welcomed, but it is in this one.
I shall talk about the claiming of tax credits. New clause 5 calls upon the Chancellor to
“publish a review in relation to the cost of making claims...before 1st March 2007”
and to
“consult with organisations which have a special interest”
in that particular area.
The Government and the Financial Secretary are proud of the introduction of tax relief for R and D expenditure, but the fact that it is available does not necessarily mean that it is accessible to all businesses. The Treasury needs to think about the cost of claiming those credits and how it might be made easier, and about who is currently excluded by the complexity of the system.
The Institute of Chartered Accountants commissioned independent research into the R and D tax credit, and the claiming of it. In the context of the debate on the schedule and the new clause, it is worth reflecting on that research. The report highlighted some of the challenges faced by businesses without the resources to make claims, and the impact on those businesses.
A large business with a well-funded R and D programme will find it relatively straightforward to make a claim, because it will have the systems and procedures in place, and the technical expertise to claim efficiently and effectively. The institute’s research indicated, however, that that did not necessarily lead to an increase in R and D expenditure, because the business had already maximised its programme. That is, the business would already have made the decision on how much to spend, and the decision would not be particularly affected by the nature of the offered incentives.
Medium-sized businesses, on the other hand, did actually benefit from the tax credits. They tend to be have better resources and to be better able to go through the process of making claims. The view was that the tax credit has been very helpful for them and has enabled businesses to grow without having to seek further venture capital funding. Businesses that have taken advantage of the tax credit have commented to me that it has aided their cash flow, and that they have not had to raise funding from outside sources.
The area of greater concern is that of smaller companies, and the Government need to think about that. The report quoted the example of a small business run by two scientists, which did not have adequate human resources to complete the returns, and so did not submit a claim. It therefore missed out on the incentives brought by the R and D tax credit.
As to the cost of preparing the returns, the indications were that it could cost approximately £12,000 to employ a chartered accountant to fill out the returns fully and to provide all the necessary support and administrative back-up. That is quite a significant sum. The taxpayer would need to consider the cash-flow benefit that it would receive from submitting the return and obtaining the tax relief, and whether it would be worth spending £12,000 of the small resources available to most small companies in order to make the claim.
Alternatively, the company could decide that it needed only to be briefed by a chartered accountant, in which case it could submit a claim itself. It was estimated that such a briefing would cost approximately £3,000, but the HMRC would come back and question the claim. I am not disputing the need for HMRC to ensure that claims are valid, but there is a cost in time and resources, including financial resources.
In preparing for the debate I looked at the guidance that is available to small businesses on the HMRC website, because one might ask why one should spend £3,000 on a chartered accountant if one can go to the HMRC website to find the information. In saying that I am probably doing a great disservice to fellow accountants who are still practising, but on looking at the website I was struck by why it would be difficult to complete a return without professional assistance. There is a series of user steps that companies need to take to determine whether they qualify, and there is a web page entitled “Is it worth reading any further?” which has a flow chart with more than a dozen boxes. If I were hard pressed for time I think I might question whether it was worth reading further.
Nevertheless, I continued, and I came across theR and D tax credit claim template for SMEs, which has a number of different lines for completion relating to, for instance, consumable items, consumable stores, computer software, staffing costs, externally provided workers, payments to staff providers, issues about connected persons, underlying relevant expenditure, subcontracted activities and payments to subcontractors. That is a lot for a small business to consider and I can understand their having difficulty with it. However, there are pages of helpful guidance to underpin it. I have one here headed “CIRD82400—R&D tax relief: categories of qualified expenditure: consumable items: meaning of consumed or transformed.” That sounds fairly hopeful. The first sentence begins:
“It is not possible to offer a simple definition”—
that supports my case that we need more chartered accountants to help by providing us with advice. However, it continues—
“because of the variety of possible circumstances.”
It goes on to say that it is specified in statute that
“the term ‘consumable or transformable materials’ includes water, fuel and power...Apart from these specific items, we then have to deal with the generality of the wording.”
I am reminded of the comments of the Financial Secretary during the last debate in which we discussed the importance of using general wording so that we do not need specific items. However, specific items might be helpful for somebody completing an R and D tax relief claim. The form says that
“A good example of a consumable item would be a laboratory chemical used in the R&D process which is used up...or converted to an unusable product.”
I am sure that scientists will be able to work their way through that. I quote this not for cheap laughs but to demonstrate the complexity that businesses face in trying to deal with some of the issues. Another page of guidance, “CIRD82500—R&D tax relief: categories of qualifying expenditure: software”, sounds as though it could be fairly straightforward. It rightly mentions that software, directly employed, can be used. However, it goes on to talk about the apportionment of software that a business might already have:
“Where software is only partly employed in direct R&D an appropriate apportionment of the expenditure should be made.”
So I suppose that if a business bought a licence to use Microsoft Office, and used Excel spreadsheets for the purpose of tracking the expenditure for R and D tax credits but also for some of the calculations that are required for research, it could apportion the cost of that software to the R and D tax credit. It rightly says that a pragmatic approach should be adopted. I make these comments to illustrate the scale of the challenge that is faced by businesses trying to claim these reliefs.
The other aspect is not the complexity and the record keeping that is required, but the degree of uncertainty about the likelihood of success of a claim. Companies with a stable and recurring path of expenditure find it relatively easy to claim tax credits. However, evidence collected for the ICA report suggests that that is not a universal experience; there can be issues about what constitutes R and D expenditure according to HMRC. Often, people’s decisions to invest in R and D are irreversible. Once the die is cast, that is it: they are going forward. Particularly in the case of a smaller business, the extent to which the likelihood of success of a claim is under question might have an impact on its willingness to make that irreversible decision.
In that context, the Financial Secretary was right to highlight the importance of setting up dedicated teams to tackle R and D tax credits. A concern that was highlighted by a number of respondents to the survey was that although some tax offices are very experienced—I should imagine that the one that serves Silicon Fen in Cambridgeshire would be very adept at dealing with such claims—there could be problems for somebody whose tax office did not have that experience. The dedicated teams that the Minister mentioned will help to tackle that.
I hope that in ironing out the wrinkles, to use the metaphor introduced earlier by my hon. Friend the Member for Braintree, the Financial Secretary will reconsider the cost of making claims, and think about what further steps can be taken to simplify claims, to provide better guidance to taxpayers who might want to take advantage of the relief, and to ensure that tax relief is not just available but accessible to smaller businesses.

Julia Goldsworthy: In their own terms, the new clause and schedule are rational and attempt to simplify the process by aligning the claims processes and time limits for R and D tax reliefs with those of enhanced deductions. However, I should like to follow the points made by the hon. Member for Fareham by considering the impact of the changes in tax credits on small businesses and the knock-on impact that they may have on them again. If all claims need to be made in company tax returns within 12 months of the filing date, what will be the impact of these changes on small businesses? Given that that is already a difficult administrative burden for them, reducing the time scale will be an additional difficulty.
There is still an issue with small businesses having to pay up front and claiming back tax credits. I should like to quote one conclusion from the report by the Manchester and Nottingham business schools, commissioned by the Institute of Chartered Accountants in England and Wales, which says:
“R&D tax credits on offer in the UK are similar to some of the best schemes offered around the world. The incentives are relatively more generous to smaller firms. The application process, however, diminishes the effectiveness of the policy and this is especially so for smaller firms and firms with small R & D programmes. In some cases the costs of preparing and administering claims prevents firms from taking advantage of the incentives.”
Given those conclusions, I wonder whether the Government really consider this to be an efficient mechanism for supporting small businesses in particular.

Rob Marris: It is a pleasure to follow an entertaining speech by the hon. Member for Fareham. I say to my hon. Friend the Financial Secretary that I have some sympathy with new clause 5. [Interruption.] Before the hon. Gentleman gets too excited, I should say that the new clause is perhaps a little premature for the reasons to which he and my hon. Friend adverted in a previous debate.
The Red Book says, on page 62, paragraph 3.80:
“In ‘Supporting growth in innovation: next steps for the R&D tax credit’, published in...2005, government announced that HMRC would set up dedicated R&D units to handle all SME claims for tax credits. It is envisaged that these units will be fully operational across the country before the end of the year. At the same time, a statement of practice will be published presenting the standard of service and support that SMEs can expect from the new units.”
I understand that, at the end of the calendar year 2006, the dedicated SME claims units for R and D tax credits and statements of practice will be in place.
New clause 5 suggests a date of 1 March 2007 for the research to be done on the costs of claiming R and D tax credits. Understandably, we have a particular concern for SMEs. I am delighted that the Budget extended the number of employees from 250 to 500 in respect of the beneficial arrangements. However,1 March 2007 is a little bit early for a procedure or new way of doing things—including new support and so on—in respect of provisions that will be in place by the end of 2006. However, if the Government have not already included such provision in the Finance Bill next year, the hon. Gentleman might consider tabling a new clause similar to new clause 5.
I have sympathy with the hon. Gentleman’s approach. To echo the comments that have already been made, I say to my hon. Friend the Financial Secretary that we have to be careful that we do not have a wonderful tax regime that is too difficult for people to claim under and therefore does not boost R and D in the United Kingdom in the way that all hon. Members wish.

Stewart Hosie: I am intrigued by new clause 5, and I hope that the hon. Member for Fareham can offer some enlightenment. It suggests publishing a review, having first consulted organisations with a special interest in claiming the tax relief forR and D. Would he envisage that the organisations consulted may not offer feedback in the published review that would make the R and D tax credit system more effective and efficient, but might suggest alternatives to it, at least in some small way?
I have said previously to the Financial Secretarythat in 2004-05, the last year for which I have figures for R and D tax credits and other R and D funding for Scotland and England, £670 million was budgeted to be made available for the tax credits, but only £290 million was actually taken up. In the same year—the figures are useful and interesting in this regard—in addition to the tax credit, a total of £710 million of Government funds were available, of which some £37 million came through collaborative research and development, knowledge transfer networks, knowledge transfer partnerships, grants for research and development, and the grant for investigating an innovative idea. The latter two apply only to England. In the same year in Scotland, some £16 millionwere available through Smart Scotland, SPUR, SPURplus, Score, SEEKIT, R & D Plus, and the small company innovation support scheme, which also includes a certain element from the Highlands and Islands Enterprise area.
Given that £670 million of tax credits were budgeted for, of which only £290 million were taken up, these small, more targeted schemes seemed to be quite successful, and the take-up seemed quite high. Does the Financial Secretary envisage that in the published review of the consultation, he will look for feedback from companies to have the Government’s research and development funding provided through such other mechanisms, not merely through the R and D tax credit system, of which, in certain years, only 50 per cent. of the budget has been taken up?

John Healey: There appears to be something of myth around that, somehow, the R and D tax credit is costly to operate from a company’s point of view, and too difficult to operate in order for companies to claim. Frankly, if that were the case, I do not think that£1.8 billion-worth would have been claimed so far by companies, including £1 billion by small firms. Alongside that, I do not think that I could have been clearer. Since the system’s introduction—first for small firms; then for large companies—we have been ready, and have proved that we shall continue to look at its costs for business. We have been willing to improve, and have improved, the process for applications and administration where we can. We have also been ready and willing, and continue to be so, to improve the guidance that is available to firms if suggestions that seem sensible to us are made.

Julia Goldsworthy: Does that mean that the Financial Secretary rejects the conclusions of thework commissioned by the Institute of Chartered Accountants for England and Wales that found that there were significant difficulties for smaller businesses in accessing these credits?

John Healey: Is the hon. Lady aware of how many companies constituted the study to which she refers? The answer is 10. I shall come to that shortly.
The schedule before us is not a big move; it is a modest move, and should help companies in the process of claiming tax credit. Harmonising the rules for claiming across the two elements of the R and D tax credit system ought to make it easier for companies to understand the claims process, and improve the incentive effect of the schemes.
New clause 5 urges us to publish a review and a report by 2007. However, we have gone further than that. We have already commissioned an independent survey of almost 1,000 R and D performing companies, looking at their experiences in claiming tax credits, the results of which we published last year, In contrast, the Manchester business school study was based on interviews with just 10 R and D performing companies. Members of the Committee could reasonably conclude that that was not the strongest piece of evidence. Interestingly, the results from that very small study contrast strongly with the results of the much wider first-stage evaluation that the Government undertook. The results of the latter, in contrast to the points made earlier, were very positive. It found that three quarters of the companies that had claimed R and D tax credit found the claims process fairly or very easy. That does not suggest that the costs of claiming are prohibitive, and experts generally agree with that view.
Finally, a recent article in Tax Journal surveying the R and D fiscal incentives in the UK compared with the US, Canada, Japan, Austria and the Netherlands, stated:
“For SMEs, the UK system is widely regarded as the most generous and the simplest to administer”.

Mark Hoban: I am grateful for the Minister’s response. He is right to highlight the nature of the survey by the Institute of Chartered Accountants, which acted almost as a focus group in the way it carried out its work. Hon. Members on both sides of the Committee are aware of focus groups and the role that they play in modern politics. Perhaps the ICA should not be criticised for adopting the techniques with which so many of us are familiar.
So that the Committee is clear about the structure of the survey, 10 businesses were involved in R and D and five people who were interviewed were involved in manufacturing. Any manufacturing business today that does not invest in R and D is likely to suffer from the competitive challenge posed by India, China and eastern Europe. It is entirely reasonable to discuss with businesses their experience of R and D. I do not necessarily concur with the Financial Secretary that it is a myth that it is costly to claim, as there are issues that affect the cost of claims that the Government should think about and it is helpful to keep the system under regular review.
I say to the hon. Member for Wolverhampton, South-West that I wish the Standing Orders had allowed us to discuss new clause 5 to capture his mood of co-operation and harmony. I am pleased that he expressed support for a simpler tax system and I am sure he will warmly welcome the outcome of the Tax Reform Commission’s report on simplification later this year, which will contain much for him to comment on positively.
The hon. Gentleman is perhaps right to say that the date of the review should be moved backwards. I hope that the system of dedicated units will be evaluated as they are rolled out, rather than waiting until the full roll-out is completed across the country. I will not be setting the terms of the review as I do not expect to become Chancellor of the Exchequer shortly, but I am sure that the Chancellor will take note of the hon. Gentleman’s comments.
The hon. Member for Dundee, East (Stewart Hosie) made a valid point about the complexity of the support on offer to businesses investing in R and D and taking up new developments. A theme taken up by businesses in my constituency and expressed to me is that there are several different means of support as well as R and D tax credit and that it can be difficult to navigate their way around them.

Question put and agreed to.

Schedule 3 agreed to.

Clause 30

Temporary increase in amount of first-year allowances for small enterprises

Julia Goldsworthy: I beg to move amendmentNo. 60, in page 28, line 20 [Vol 1], leave out ‘12' and insert ‘24'.

Joe Benton: With this it will be convenient to discuss amendment No. 61, in page 28, line 31 [Vol 1], leave out from ‘in' to end of line 32 and insert
‘2006-08 or financial year 2006 and 2007.”.'.

Julia Goldsworthy: These are probing amendments that consider the rationale behind the proposed changes to the time scale that apply to the increased amount of allowances for small enterprises. The clause proposes a temporary change to the first-year allowance of one year, which the amendment would extend to two years in order to try to understand the rationale for increasing the allowance to one year. Could the Financial Secretary explain how small businesses will be capable of responding to these relatively small and rapid changes? If the change proposed is introduced, the allowance will have changed from year to year in four consecutive years. I have received many representations from people who feel that the changes add to the regulatory uncertainty and the—

It being One o’clock, The Chairmanadjourned the Committee without Question put, pursuant to the Standing Order.

Adjourned till this day at half-past Four o’clock.